Retail and real estate play a key role in the economy's expected recovery.by Sarah Max

NEW YORK (CNN/Money) - The stock market is in purgatory. Unemployment is at its highest rate in six years. And the 3.5 percent economic growth we've taken for granted over the past decade has come to a crawl.

All things considered, the American consumer has held up pretty well. Although Consumer confidence isn't what it was a year ago, 46 percent of those surveyed in a recent ABC/Money magazine poll feel that now is a good time to buy things. Retail sales, while down, are better than initially expected. The housing market, meanwhile, has remained solid. As long as consumers keep the faith, say economists, the recession could be mild and over before we know it.

"We think we're going to see recovery by second half of the year and that growth can be quite brisk," said Josh Feinman, chief economist for Deutsche Asset Management. Of course, the wild card in every forecast is the progress in the war on terrorism. "That's a risk for sure and it's a risk that's hard to handicap," said Feinman.

"If Osama bin Laden were caught tomorrow, that would cause holiday sales to skyrocket," said Bill Dreher, a retail analyst at Robertson Stephens.

Shop til you drop

There's a reason why politicians are telling the American people to do the right thing and get to the mall. "Consumer spending is the 800-pound gorilla when you're talking about the economy," said Feinman. "It's two-thirds of the economy."

Retail sales have gone up and down all year, but we won't fully understand what's going on in the minds of American shoppers until the last Christmas gift has been unwrapped. The holiday shopping season accounts for 20 to 25 percent of all retail sales and is also a barometer for the coming year. "We're not out of the woods yet," said Dreher. "Forty percent of holiday sales are wrapped up in the week before Christmas."

Widespread unemployment, terrorism fears and 70-degree weather have put a damper on the holiday spirit. According to an American Express survey, consumers will shop later in the season and spend 7 percent less this year. As of December 16, holiday sales at specialty stores were down 3 percent from the same time last year, according to the International Council of Shopping Centers.

But there are some factors working in retailers' favor. The refinancing boom has lowered monthly mortgage payments and helped pay off credit card debt. Credit card debt reached an all-time high in June at $699 billion but has actually fallen for the past four months, according to Economy.com.

A 25 percent drop in energy prices is also breathing some life into household finances. "The low energy prices are more beneficial than any tax break, particularly for discount shoppers," said Dreher.

And not every category is down and out. Music, video and home entertainment sales have been outpacing last year's sales. Wal-Mart broke records on Black Friday (the day after Thanksgiving) with $1.25 billion in sales. And e-commerce sales are 30 percent better than they were last year, according to Bizrate.com.

"People who spent money on travel and luxury goods are spending more money entertaining themselves at home," said Celia Chen, senior economist for Economy.com.

Thanks to low rates and rebates, auto sales in October and November were 24 percent and 6 percent higher than their average for the previous nine months. But because cars aren't the kind of thing people buy every month, the recent flurry of sales bodes badly for future sales. Fewer cars are coming off the lot this month, and the first quarter of 2002 is expected to be a slow one for Motor City.

Deck your halls

If there's been one safe haven in the economy, it's been in your own living room. "With job loss and credit quality as it is, you would think demand for housing would be more depressed, but it has remained remarkably resilient," said Chen.

"Housing prices have been an important source of keeping wealth and have dampened the effects of the weak stock market," said Feinman. "If they turned down in value that could jeopardize recovery."

Although new home prices have come down slightly, the housing market seems to be in no danger of collapsing. You can thank falling mortgage rates for the sturdiness of residential real estate. Because lower rates translate to lower monthly payments, buyers are willing to borrow slightly more than they are in a high-rate environment.

Housing, however, tends to lag the rest of the economy in its ups and downs. So as the effects of unemployment play out, home values could come down. "I think we'll see some softening next year," said Ken Riggs, CEO of Real Estate Research Corporation, noting that luxury homes in hot markets will suffer more than mid-priced homes in solid neighborhoods. "Mortgage rates have been a positive factor, but personal income isn't growing and job losses are high."

To be sure, even as economists keep a close eye on consumer confidence and how it plays out, they say the most important indicator for next year's economic comeback is the labor market.

Here's where the economic chicken-or-the-egg scenario comes into play. Consumers' willingness to shop, buy houses and invest in the stock market will help determine the fate of the economy and ultimately the fate of the labor market. But if unemployment rates continue their upward trend, consumers will sit on their wallets and the recovery will be slower coming.